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This Fund Takes a Sensible Approach to Small-Value Stocks

Despite recent hiccups, Boston Partners Small Cap Value II's deliberate approach should reward investors over a full market cycle.

The following is our latest Fund Analyst Report for Boston Partners Small Cap Value II (BPSCX). Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

A veteran duo plies an effective approach, earning Boston Partners Small Cap Value II's institutional share class a Morningstar Analyst Rating of Gold, while the pricier investor share class drops to Silver.

A strong comanager contingent stands out here. David Dabora has been a manager here since December 1998 and boasts 30-plus years of industry experience. He collaborates on portfolio construction with comanager George Gumpert, who has been a comanager here since December 2005 and boasts over 20 years of industry experience. David Hinton, a generalist equity analyst, rounds out the core team. He has served as a generalist analyst of small- and mid-cap stocks since 2002. The managers can also make use of Boston Partners' centralized group of more than 20 research analysts. An impressive array of resources sets this team apart.

The team has successfully executed this strategy's disciplined approach, rooted in deep due diligence over multiple market cycles. It applies Boston Partners' sensible, bottom-up approach that looks for small- and micro-cap companies with three key characteristics: attractive relative valuation, sound fundamentals, and positive business momentum. While it's allocated more to micro-cap stocks in the past, it has proved that it can deliver alpha for investors across the market-cap spectrum. Indeed, the team's stock-picking prowess has rewarded investors who have stuck with it.

The strategy has faced some challenges more recently but remains a winner over the long haul. From longest-tenured manager Dabora's December 1998 start through September 2020, the I shares' 10.4% annualized gain trounced its average small-cap value Morningstar Category peer and the Russell 2000 Value Index by 3.0 percentage points each. It looked similarly compelling on risk-adjusted metrics. It has generally lost less than the benchmark in down markets, but that was not the case in 2020's first-quarter bear market. Despite recent hiccups, the team's adherence to its deliberate approach should reward investors over a full market cycle.

Process | Above Average
A thoughtful approach to value investing that has demonstrated its edge across several of Boston Partners' charges leads to a Process rating of Above Average.

Comanagers David Dabora and George Gumpert's process follows Boston Partners' sensible, bottom-up approach that looks for companies with three key characteristics: attractive valuation, sound fundamentals, and positive business momentum. The team efficiently narrows its investable universe by applying a quantitative screen that looks at roughly 4,000 stocks with market caps generally between $100 million and $6 billion. Some of the metrics used include price/earnings, price/book, and return on equity.

Deep due-diligence work and stock-picking prowess sets this team's approach apart. It looks for companies with sustainable competitive advantages, strong fundamentals, and good capital-allocation practices. Each name is modeled one to three years out and assigned a target price. While it emphasizes fundamental strength, the team does not shy away from leveraged businesses, as demonstrated by the portfolio's above-benchmark debt/capital ratio, but it does so responsibly. For example, during 2020's coronavirus tumult, the team conducted a detailed risk assessment of each stock that emphasized balance sheet strength. The team's detailed research has historically rewarded investors with strong downside protection.

People | High
This strategy is backed by a focused team of industry veterans. While small, this team's deep industry knowledge and hands-on experience in the small- and mid-cap arenas ensures that it has adequate resources. Further, the team has Boston Partners' deep central analyst bench at its disposal. The strategy continues to earn a High People rating.

An experienced comanager duo sets this team apart. David Dabora has been a manager here since December 1998 and boasts 30-plus years of industry experience. He shares portfolio decision-making responsibility with comanager George Gumpert, who has been a comanager since December 2005 and offers over 20 years of industry experience. David Hinton rounds out the core team. He has served as a generalist analyst of small- and mid-cap stocks since 2002.

The managers can also make use of Boston Partners' centralized group of more than 20 research analysts. They tend to draw upon the expertise of that cohort's sector analysts in cases where more-detailed knowledge is warranted. The managers say they tend to use the energy and financial analysts most heavily. Further, during times of market volatility, the team may lean more heavily on the central bench. For example, in 2020 the comanagers were speaking with the team daily and relied on this group for support on a comprehensive risk assessment for all stocks in the fund's portfolio.

Parent | Above Average
Boston Partners is a high-quality asset manager that has a strong investment culture and puts investors first. The firm, established in 1995, became part of Robeco Group in 2002, which was bought by Japanese financial conglomerate Orix Corporation in 2013. Boston Partners still operates autonomously and managed $89 billion as of October 2019, both under its own branding name and as subadvisor for John Hancock in the United States and Robeco in Europe. It offers a concentrated fund lineup of high-quality strategies that use the same investment philosophy and process. The firm's investment-driven culture, focused on long-only and long-short value investing, features a clear and consistent research process that has translated into good outcomes for investors. All funds that we rate qualitatively are Morningstar Medalists. Although its menu has somewhat expanded over the years, Boston Partners has not moved away from its key tenets, and the more recently launched funds are variations of proven concepts. Retention of employees and co-investment by fund managers are strong. The firm acts prudently when launching new funds, operates within its circle of competence, and carefully monitors capacity, which has resulted in closing some funds to protect investors' interests. This is a commendable asset manager that deserves an Above Average Parent rating.

Price 
It's critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar Category's second-costliest quintile. That's poor, but based on our assessment of the fund's People, Process, and Parent Pillars in the context of these fees, we still think this share class will be able to overcome its high fees and deliver positive alpha relative to the category benchmark index, explaining its Analyst Rating of Silver.

Performance 
The strategy boasts a solid track record over the long term but has struggled recently. From longest-tenured manager David Dabora's December 1998 start through September 2020, the fund's I shares' 10.4% annualized gain trounced its average small-cap value category peer and the Russell 2000 Value Index by 3.0 percentage points each. While it’s riskier, as measured by standard deviation, it also handily tops its bogies on risk-adjusted metrics such as Sharpe and Sortino ratios.

Strong stock selection, which has resulted in attractive downside protection over time, has driven compelling long-term results but more recently the strategy has struggled on the back of mixed stock-picking. For example, over the trailing one-year through September 2020, stock picks in the consumer cyclical and real estate sectors, such as KAR Auction Services (KAR) and Two Harbors Investment (TWO), have detracted the most. Nevertheless, under Dabora's watch, the fund still boasts a 90% downside capture ratio relative to the benchmark while catching 102% of its upside. While this strategy tends to deliver strong downside protection, that was not the case during 2020's first-quarter coronavirus tumult, when it lost 39.0% relative to the benchmark's 35.7% drawdown. While the team's approach won't always work, investors remain in capable hands.

Portfolio 
Comanagers David Dabora and George Gumpert collaborate to build a portfolio of 100-200 stocks. Despite a sprawling portfolio, the team's deep research effort uncovers unique investment opportunities, so it maintains relatively high active share. Active share is typically more than 90% relative to the Russell 2000 Value Index.

The team's quality focus means that the portfolio looks higher-quality on most measures, but it's mixed on valuation metrics. Specifically, the portfolio boasts higher average return on equity, return on assets, and return on invested capital than the benchmark. It looks cheaper on average price/free cash flow and price/earnings, but its average price/book ratio is higher than the bogy's.

Patience with winners means the portfolio's average market cap can also look a bit high relative to its benchmark, as has been the case in recent years. Further, it continues to hold a low allocation to micro-cap stocks. As of May 2020, portfolio had a $2.1 billion average market cap, versus $1.4 billion for the Russell 2000 Value Index. In June 2018, the portfolio's 7.3% stake in micro-cap stocks was 5.3 percentage points less than the Russell 2000 Value Index's share. That's the lowest it has been since the strategy's launch, and it hasn't increased much since. While the team attributes this trend to a lack of opportunity, it's something to watch as the strategy continues to garner assets.

Linda Abu Mushrefova does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.